FINC2011 Corporate Finance

You are starting an internshipatalargeinvestment fundcalled “WhiteRock”. Your manager has tasked you towrite a reportfor a clientthat compares the potential return and risk profilesof different investmentopportunities.Given the uncertainty with current financial markets, this client is considering investingonly for themedium term (approximately 5 years).The investment fund isthinkingwhethera well-diversified or limited diversification strategy would be preferablefor this client. You expect that extra returns could be generated as compensation for bearing more risk.

Required:

1.Select two stocks and an appropriate market indexfrom the Australian Securities Exchange (ASX), London Stock Exchange (LSE) or New York Stock Exchange (NYSE). The two stocks will form thelimited diversification portfolioand the market index will be the diversifiedportfolio. Justify why these two stocks are appropriate choices to combine together andyourchoice of a relevant market index.

2.Estimate and compare the returns and standard deviationof each stock and the market index over an appropriate time period. Justify your data choices.

3.Calculatethe beta of eachof the twostocks.Justify your data choices.

4.Calculate the expected return of each stock using the Capital Asset Pricing Model (CAPM).Justify your data choices.

5.Construct a series oflimited diversificationportfolioswiththe twochosenstocks by varying the weights of eachat 2.5% increments–starting at 100% invested in Stock X and then increasing the weight of Stock Y until it reaches 100%. Calculate the expected return and beta of each portfolio. The results should be presentedon an appropriate graph.6.Provide a final recommendation tothis clienton the most appropriatechoice(s)that they should invest in and how it could be implementedmostoptimally.